5MF (WEEK 33): BURRY’S BIG MOVE, IRS-CRYPTO, ONE STOCK BEAT S&P IN 5 PREVIOUS RECESSIONS

Five Minute Finance

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BLOCK6

10 min readAug 19, 2022

The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.

Let’s see what’s going on this week:

Alphabet’s $1.5B Foray into Blockchain Investments
IRS Receives Court Order to Retroactively Track Crypto Txs
Tether (USDT) is Turning Over a New Audit Leaf
The One Stock that Beat the S&P500 in Previous 5 Recessions
Big Short Michael Burry Abandons Market Ship

Alphabet Sees Alpha in Web3

Break Down of Alphabet’s $1.5B Blockchain Investments So Far (link)

Will Web2 Successfully Build Web3?

It has become common to say that the next version of the internet — Web3 — is read-write-own, vs. Web2’s read-write model.

Image courtesy of Twitter.

Web1 unlocked new ways of accessing vast amounts of information. People went from manually flipping through the pages of an encyclopedia to searching a query via Google.

Web2 allowed people to create content and communicate in new ways. Individuals with internet access could seemlessly publish posts and photos via social platforms thanks to ‘Web2’, for example.

Web3 aims to enable publishers to own the content they create, and receive some of the revenue it generates. Think about an individual on twitter for example, with a very large following who is quite active. Twitter generates revenue from various ads displayed to this individual’s following, but the individual doesn’t get a slice of that pie in Web2.

The “own” part in Web3 comes from decentralization made possible by trustless consensus mechanisms that enable peer to peer transactions via blockchains. Bitcoin paved this road as the first P2P money with no CEOs or governance boards.

While Bitcoin’s smart contract is laser-focused on making the money market equitable, Web3 expands smart contract flexibility to the max: tokenizing all aspects of traditional finance and online ownership.

Bitcoin started as an experiment. It had privacy and decentralization enthusiasts as early adopters which, over the course of several years, contributed to increasing the security of its network.

Things are a bit different with Web3. It has received quite a bit of funding to accelerate its development.

Web3’s biggest funders are familiar names. At third and second place are MorganStanley and BlackRock, at $1.1B and $1.17B each from September 2021 to June 2022. The top Web3 funder is none other than Alphabet, Google’s parent company, having invested $1.5 billion in the same period through its four venture vehicles:

CapitalG: 106 investments vs. 25 exits.
GV: (former Google Ventures) 988 investments vs 225 exits.
Gradient Ventures: 158 investments vs 17 exists.
Google: 253 acquisitions, 181 investments vs 42 exits.

And just like Alphabet has its hands in all Web2 pies, its Web3 investments follow the same infrastructural road. Alphabet picked leading Web3 chokepoints:

Dapper Labs: For all things gamified and NFT’d starting with mainstream sports, thanks to its Flow blockchain and Visa/MasterCard payment rails. Google even bolstered Flow with its Cloud servers for maximum efficiency and low latency.
Fireblocks: Businesses are rarely run by single individuals, which makes joint digital custody cumbersome. Fireblocks solves this problem with multi-party computation (MPC) wallets. So far, the Fireblocks network has handled the transfer of $2 trillion in digital assets across 800 orgs.
Voltage: The main server provider for Lightning Network, Bitcoin’s gateway into mass adoption by facilitating near-instant payments.
Digital Currency Group (DCG): The VC firm that you have heard mentioned in the funding of nearly every blockchain startup worthy of note. Out of 284 investments, DCG was the lead funder in 29, from crypto reward programs to Web3 data collection for risk assessment.

Web3 does entail ownership via tokenization, but so far, it seems to be on terms Web2 corporations decide.

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The Start of an IRS Crypto Crackdown?

Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Cryptocurrency (link)

Fishing for Tax Avoidance, Retroactively

ICYMI: the US Inflation Reduction Act increased IRS funding by nearly $80 billion, and added a veritable army of 87,000 new tax collectors.

And it’s safe to say the IRS is stepping up its crypto focus, by going after previous transactions.

The IRS issued a “John Doe” summons to SFOX, a crypto broker, this past week.

The IRS deploys this legal action when it doesn’t exactly know who it’s going after, or any other details. As a result, it needs, well, what could be described as a free-range hunting license.

Not only will the IRS go through SFOX records to verify if all cryptocurrency transactions were reported, but it will do so retroactively.

“U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency between 2016 and 2021 with or through SFOX.”

Previously, the IRS issued such summons to Coinbase, Kraken, and Circle. In the larger scheme of things, this is quite predictable. Just yesterday, the Korea Financial Intelligence Unit (KoFIU) placed 16 crypto exchanges on notice if they don’t register and make their customers reportable.

Tether Ups Its Audit Game

Tether Hires New Auditor to Publish Monthly Proof of Reserves (link)

Will USDT Finally Leave the Dark Shadow of Speculation?

Ironically, it cannot be overstated how much stablecoins underpin the entire DeFi economy, as they make the bulk of lending and borrowing smart contract collaterals. Because they are tokenized dollars, stablecoins provide refuge from crypto’s wild price swings and are critical for DeFi to function.

After Terra’s algorithmic UST stablecoin showed that it cannot be stable, all stablecoins are now doubly scrutinized. After that meltdown, USDT briefly uncoupled from the USD, adding to worries that its reserves are not sufficient in extreme market conditions where a large number of investors want to redeem their USDT stablecoins for dollars.

Tether’s depeg was brief and slight, but raised concerns nonetheless. Image credit: Kaiko

Seizing the opportunity, Circle, the issuer of USDC (the second largest and most regulated stablecoin), introduced weekly audits and detailed asset breakdowns. In contrast, Tether’s USDT was always under suspicion. Is it fully collateralized with redeemable cash reserves?

Here are just some of the reasons users have voiced over such suspicion:

Paying an $18.5 million fine for making false claims about USDT’s dollar reserves.
Bitfinex exchange using USDT to mask missing $850 million.
Holding commercial paper notes to the tune of $30B in July 2021, but assuring it will be reduced to zero by November 2022.
Not even showing up to December’s congressional hearing on stablecoins, despite being the largest stablecoin issuer.
Denying having a relationship with troubled Chinese real-estate developer Evergrande, simultaneously as Tether’s lawyer refused to say whether Tether holds Chinese commercial paper as a collateral.

At one point, John Betts, the former CEO of Noble Bank International (holding some of Tether funds) framed USDT extremely unfavorably:

“It’s not a stablecoin, it’s a high-risk offshore hedge fund,”

He based that opinion on Giancarlo Devasini’s (Tether CFO) habit to use Tether funds for loans on various CeFi platforms, such as bankrupted Celsius.

As a result of all of this, USDC has consistently inched its way toward USDT’s market cap. But recently, that trend stopped:

Over the last month, USDT market cap went up by +2.6%, while USDC’s went down by -3.5%. Image credit: CoinMarketCap

Just as USDC was on the rise, it lost some steam after freezing some USDC associated with Tornado Cash. USDC may be regulated, but Circle also enjoys the $400 million worth of confidence from BlackRock, which is somewhat lacking in trustworthiness across social media circles.

With the perception upturned, Tether is now doing what USDC did when USDT slightly unpegged — upping its audit game. Tether selected BDO Italia for its new auditing firm in charge of its dollar reserves, belonging to BDO Global, the world’s premiere independent public accounting firm.

Furthermore, Tether announced it will do monthly audit reports instead of quarterly.

Whether Tether’s past misdoings are taken maximally negatively, stablecoin competition appears to be producing a more robust financial product.

Lastly, it is quite telling that billionaire FTX CEO Sam Bankman-Fried, the crypto bailout king who refused bail out Celsius, has no Tether worries:

“I think that the really bearish views on Tether are wrong…I don’t think there is any evidence to support them.”

Some Stocks Just Seem Resilient to Recessions

Can Walmart Outperform the SPY if the US Enters a Recession? (link)

Recession Impact: Investors Exit Discretionary Stocks

While the Fed is working to cool down the overheated economy, indvidual purchasing power is on the decline. The data that cuts through the noise is clear:

US household debt is $2T higher than the pre-Covid levels, at a record $16.15T, indicating a rapid dwindling of savings, i.e., people’s purchasing power.
Wobbly consumer sentiment, from 82% reported purchasing power anxiety, twice as pessimistic as the early days of Covid.

Image credit: McKinsey & Company

The big question then is, which stocks are resilient to such pessimism and lowered purchasing power? Near the top of that list is companies that rely on mass scaling and essential goods vs. discretionary goods.

Walmart did particularly well during the ‘technical’ recession in March 2020:

WMT vs S&P 500 — the inversion difference between staple and discretionary during a recession (marked green). Walmart already reported higher than expected profits for Q2 FY23 earnings. Image credit: Trading View

Mark Satov, business strategy expert at Satov Consultants, explained this recession mindset clearly.

“If you’re in the discount world, people are going to come to you for the lowest price. And if you’re not going to be lower than Walmart, lower than Costco, lower than Amazon, people aren’t going to go there, especially during a recession.”

History agrees. Walmart (WMT) has beaten the S&P500 in the previous five recessions.

Does Michael Burry Anticipate an Economic Disaster on the Horizon?

Michael Burry’s Hedge Fund Dumps Meta, Alphabet in Q2 Purge (link)
Oil Prices Fall as China Cuts Policy Rates by 10 BPS (link)

Burry’s Market Exit Portends Something Bad, but We’re Not Sure How Bad

Michael Burry, the perpetual market bear who cleaned out $100M when he made the right call during the submortgage crisis, just sold all of his stocks except for Geo Group — a private prison and mental health operator.

What did Burry read to make that call now? First off, the mortgage demand fell to a 22-year low, with home sales down by -5.9% from June. This indicates a recession in new home building, but not necessarily in home prices, which are still +11% up since last year.

Meaning, homes still remain the least affordable in 33 years, leaving plenty of room to fall further. After all, during the 2008 Great Recession, home prices fell by -15.9%, the sharpest drop in 17 years prior.

Bill Adams, chief economist at Comerica Bank, placed these indicators into a recession box:

“Combined with downturns in tech, big-box retail, manufacturing and foreign economies, a bona fide recession looks more likely than not over the next year.”

Speaking of manufacturing and foreign economies, China’s economy slowed down so much that PBoC abruptly cut interest rates to stimulate it. With China’s GDP dropping down to just +0.4%, the world’s manufacturing hub missed all consensus estimates for retail, industrial production and fixed-asset investments.

But it doesn’t end there. The Euro zone keeps surprising the world with never-before seen electricity prices in the developed world. Suffice to say, lowered EU buying power is bound to reduce US economic activity as well, further cooling down the economy.

These assaults on the cost of living keep lowering consumer spending, which contributes to lowering inflation. If the Fed is happy with inflation decline, additional market selloffs are less likely as more aggressive interest rate hikes would see less demand.

Because crude oil prices drive half of the inflation, and they have fallen to February’s level, the present market consensus is that the Fed will hike rates by 50 bps at the next September 21st meeting, which is a reprieve from previous 75 bps.

While this would make it less likely for additional market selloffs, for some reason, Burry doesn’t exactly have a positive outlook.

All things considered though, it bears keeping in mind that everything is temporary:

Tweets of the Week

German MoM PPI was expected to be 0.7%. It was previously 0.6.
It is at 5.3%. You did not read that wrong.
Goodnight.
[PPI is Producer Price Inflation month-over-month]

@unusual_whales

JUST IN: #Bitcoin miners sold 6,135 $BTC ($133 million) since August 1st.

@watcherguru

Global Central Bank Update:
-Norway: 50 bps hike to 1.75% (5th hike).
-Philippines: 50 bps hike to 3.75% (4th hike).
-Turkey: 100 bps cut to 13.00% (5th rate cut despite inflation rising to 80% and currency collapsing).

@charliebilello

***Bullard: Fed can get inflation down over roughly 18-month period
Sure, but history says that it’ll take a recession to slow inflation down from 9% to 2% in that time frame.

@MacroAlf